IN business, institutions can be defined as set-ups and policies created as a framework for economic, legal, and social relations. Institutions work as mechanisms which an investor can resort to in a given social environment to protect his/her rights and interests. Formal institutions and policies (rules) are created by governments as a framework for economic and social relations.
FDI prefers countries where formal institutions are strong. There is an expectation that such an institutional framework is effective, impartial, credible, honest and transparent and that it protects property and individual rights; in other words, the ‘to go to’ if one feels that their ownership rights have been infringed. Institutions tend to come in two forms; formal institutions which include public institutional infrastructure such as a legal system and the rule of law as well as informal institutions.
Zimbabwe’s institutions are complex. Other than formal institutions, there are informal institutions which are known to overpower, supersede and subjugate formal ones. Informal institutions can be an individual, group of people, an organisation of even traditional leaders like chiefs. The legality of informal institutions is questionable and they mostly lurk in the shadows. This makes it very difficult to measure them.
I list below a few common statements which Zimbabweans make when making references to existence of informal institutions in the country:
“X and Y are untouchable despite their illegal business practices.”
“There is a ‘big man’ behind every successful business.”
“You must not do business with X and Y because there is nothing you can do if they breach your agreement.”
Police are known to respond by saying ‘it’s a political issue, we cannot do anything’ if reports linked to political violence are made to them.
“In Zimbabwe, it’s not what you know, it’s whom you know.”
“If you want to get farm land, you have to go through the Zanu PF provincial structure’s land committee.”
Zanu PF youths sent to evict farm owners from their farms while police watch.Advertisement
“Do you know who you are messing with? Do you know who I am?”
The highest office in the land is quoted saying; “If there is a magistrate or judge who will want to preside over this matter, then I would like to know where he/she went to school and where he/she got the powers to rule over Zanu PF.”
All these statement refer to the ‘invisible hand’, a parallel system to formal institutions which work as a mechanism through which infringements to rights are either resolved or suppressed. This parallel system also defines a set of rules, compliance procedures and norms designed to constrain the behaviour of individuals in the pursuit of business interests.
Generally, businesses need some form of institutions in order for trade to take place. It is not unusual for formal and informal institutions to have a parallel existence, although informal institutions are known to thrive in environments where formal ones are perceived to be weak. There is a school of thought that supports the view that formal institutions in Zimbabwe were deliberately weakened to ensure that informal institutions hold sway.
FDI investors prefer strong formal institutions because they generally offer the best framework that creates an even playing ground for all. By their nature, informal institutions belong to small groups which subscribe to them. Understanding the interaction between formal and informal institutions is important because it informs the investor and gives them an insight into the rules that actually apply on the ground.
There is, generally, a perverse incentive for informal institutions to undermine formal institutions. In the case of Zimbabwe, informal institutions are known to substitute and compete with formal ones to the extent that formal institutions are known to keep away from situations where informal ones are known to be at play (as is the case with the police and politics above).
This creates a situation where one chooses which institutions they wish to involve themselves in. In other words, if one felt that they are likely to get an unfavourable outcome in formal institutions one could opt to use informal ones. It is also known that people will choose not to raise their grievances if they are aware that their aggressor has strong support from an informal institution.
Generally, FDI is known to prefer countries with better quality formal institutions while poor governance can impede FDI. Suggested channels through which this happens are that poor institutions can act like a tax and therefore are a cost to FDI; they increase the uncertainty associated with all types of investment including FDI and can increase the volatility of FDI.
Besides, good governance is associated with higher economic growth which should attract more FDI inflows; poor institutions that enable corruption tend to add to investment costs and reduce profits and high sunk cost of FDI makes investors highly sensitive to uncertainty, including the political uncertainty that arises from poor institutions.
Potential investors find the costs of both formal and informal institutions prohibitive. As an example, investors have to incur costs of complying with requirements of formal institutions as well as informal institutions. The informal institutions work as some form of protection racket which demands payment. These payments add costs of operations and can prolong the time it takes before a business can operate. Informal institutions could also interfere with how your business is run.
Informal institutions are also known for not having longevity. They only last as long as the key people in them remain in powerful positions. As an example, if there were any businesses that had a ‘Gamatox’ component as their informal institution, it would have been left exposed when the Gamatox faction was obliterated in the ruling party’s factional wars. In order to manage this risk, some investors join hands with institutions that are known to have some longevity like the army or the CIO.
While investors may still invest in a country with formal and informal institutions, they seriously consider what they invest in and also add a higher risk premium to the targeted returns from that investment.
If one takes into account that Zimbabwe has to compete with other countries for FDI, it has to be a unique investment opportunity like alluvial diamonds where an investor needs a pick and shovel (rather than expensive equipment) with an opportunity for smuggling the diamonds out on the country to attract a foreign investor to Zimbabwe.
David Mutori is a former chief operating officer of a group of luxury safari camps (based in Zimbabwe, Botswana and Zambia) and Zambezi river white water rafting guide. He writes in his own capacity on topical structural issues that affect the development of Zimbabwe. He can be contacted by email on email@example.com or Twitter on @DavidMutori.